THERE ARE INSTANCES IN WHICH ACTIVE MANAGEMENT MIGHT BE MORE APPROPRIATE: THE ABILITY TO SIMPLY ACCESS A MARKET (MANAGER SKILL), AND THE ABILITY TO EFFECT CHANGE WITHIN AN INVESTMENT (PRIVATE CAPITAL).
While many would hail Boyhill as a skilled investor (others as an insider given that his cousin, Joel Boyhill, was the sponsor of the bill), he was really more of a skilled inventor—he simply solved problems of access into the real estate market. Investors who held two asset portfolios of stock and bonds could now expand and hold real estate, albeit with stock-like volatility. This type of innovation continues today and is present in our portfolios. Last year brought allocations to two Stone Ridge Asset Management funds: reinsurance and alternative lending. While we label Stone Ridge an active manager, we believe its primary skill is providing access to these markets for our clients. Alternative lending, for example, is a fund made up of more than 150,000 loans, most which make monthly payments, or at least are supposed to. The logistics, reporting, and regulation around this undertaking requires an immense amount of skill, as it is more than the repackaging of stocks and bonds in an attempt to diversify a portfolio. Investing in these types of asset classes allows us to create excess return in our portfolios by allocating to an asset class not previously available, much like the traditional investor of the 1960s. This was a direct step away from strategies which looked to do nothing but repackage stocks and bonds in an uncorrelated fashion. These are the types of investments that fit well in our Manager Skill building block. For our Private Capital building block, we prefer the ability to effect change in an investment. The “active” part of active management in stock picking typically ends after the point of purchase. After an analyst convinces her portfolio manager to buy her recommendation, she transitions to “watch mode” to ensure her thesis plays out. This consists of quarterly calls, an occasional conversation with management, and a yearly deep dive into the 10-K. Rarely during this process does the skill of the analyst actually create change in the company, and how could it when they represent 0.1% of the investor base? Their active approach has earned them a passive seat along the way. Contrast this to active management in the private capital realm. A venture capital investor will conduct due diligence of a prospective company using financial statements, management discussions, and variant conclusions, all leading to an investment in the startup. Unlike the example above, this venture capitalist can own 25% or more of the company. It is at this point that the true skill of active management takes over. The seasoned venture capital investor will develop business plans, hold material voting rights, make introductions, place C-suite personnel, and do everything he can to ensure the company succeeds. We believe success in the private capital world is sticky due to this expertise and the ability to effect real change within a company. For this reason, we are willing to ask clients to accept long lockups and to pay performance fees. While the MFS® Massachusetts Investors Trust fund will likely endure another 100 years of active management, it is impossible to know which of those years are going to be feast and which are going to be famine. We choose instead to focus our active management efforts on the other two skills since we are more confident of their ability to drive returns in our portfolios. C A P I T A L M A R K E T S F O R E C A S T 2017
15
